2.8 Market Failure: Externalities & Common Pool (Access) Resources (DP IB Economics: SL): Flashcards
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- Front2.8.1 Market Failure
Define market failure.
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Define market failure.
Market failure occurs when there is a lack of allocative efficiency from the point of view of society.
What determines the allocation of scarce resources in a free market?
In a free market, the price mechanism determines the most efficient allocation of scarce resources.
Define externality.
An externality occurs when there is an external impact on a third party not involved in the economic transaction between the buyer and seller.
Common pool resources are non-excludable but in consumption.
Common pool resources are non-excludable but rivalrous in consumption.
Define public goods.
Public goods are beneficial to society but would be under-provided by a free market because they are non-excludable and non-rivalrous.
True or False?
Demerit goods such as cigarettes are under-provided by a free market.
False.
Demerit goods such as cigarettes are over-provided by a free market, leading to an over-allocation of resources.
Give an example of a common pool resource.
An example of a common pool resource is the fishing grounds off the coast of Maine.
Define marginal social benefit (MSB).
Marginal social benefit (MSB) is the sum of the private benefits plus the external benefits from the consumption or production of one additional unit of output.
At what level of output does the socially optimum output occur?
The socially optimum output occurs where marginal social benefit (MSB) = marginal social cost (MSC).
Define marginal social cost (MSC).
Marginal social cost (MSC) is the sum of the private costs plus the external costs from the consumption or production of one additional unit of output.
At the point of allocative efficiency, surplus is maximised.
At the point of allocative efficiency, community surplus is maximised.
True or False?
When analysing market failure, the focus is on the price of the product rather than the level of output.
False.
Analysis of market failure focuses on the level of output and the resources used to generate it, less on the price.
What are scarce resources also known as?
Scarce resources are also known as the factors of production: land, labour, capital and enterprise.
Define negative externalities of production.
Negative externalities of production are external costs created during the production of a good or service that are not paid for by the producer.
Why does a market with negative externalities of production over-provide the good?
The market over-provides because producers consider only the private costs of production and ignore the external costs.
A market fails through the of goods that generate negative externalities of production.
A market fails through the over-provision of goods that generate negative externalities of production.
True or False?
If the external costs of production were considered, supply would increase.
False.
If the external costs were considered, supply would decrease and the good would be sold at a higher price.
At what point is the socially optimal allocation of resources achieved?
The socially optimal allocation is achieved where MSB = MSC, at the socially optimal price and quantity (Popt Qopt).
Define negative externalities of consumption.
Negative externalities of consumption are external costs created during the consumption of a good or service that are not paid for by the consumer.
What happens to demand if the external costs of consumption are taken into account?
If external costs are considered, demand would decrease and the good would be sold at a lower price.
Common examples of goods with negative externalities of consumption include cigarettes, alcohol, fatty foods and products.
Common examples of goods with negative externalities of consumption include cigarettes, alcohol, fatty foods and single-use plastic products.
In the worked example, what welfare loss is caused by the negative externality of production?
The welfare loss is £600,000, calculated as ½ × base (30,000 units) × height (£40).
Define demerit good.
A demerit good is a good which has external costs in consumption and is usually addictive and harmful for consumers.
Give two examples of demerit goods.
Examples of demerit goods include gambling, alcohol, drugs and sugary foods/drinks.
True or False?
Electricity is classed as a demerit good because power stations create pollution.
False.
Electricity is considered a merit good; the smoke is a by-product and not a good or service, so demerit goods are goods used in consumption.
Define positive externality of production.
A positive externality of production is an external benefit created during the production of a good or service, over and above the private benefits gained by the producer.
Why does the free market under-provide goods that generate positive externalities of production?
The free market under-provides them because producers consider only their private benefits and not the external benefits of production.
Define positive externality of consumption.
A positive externality of consumption is an external benefit created during the consumption of a good or service, over and above the private benefits gained by the consumer.
True or False?
Goods that generate positive externalities of consumption are over-consumed in the free market.
False.
They are under-consumed, because consumers consider only their private benefits and not the external benefits.
For a positive externality of production, the socially optimum allocation of resources occurs where MSB equals .
For a positive externality of production, the socially optimum allocation of resources occurs where MSB equals MSC.
Give an example of a positive externality of production.
The production of honey increases the number of bees in an area, which increases pollination and can help other nearby food producers.
Define merit good.
A merit good is beneficial to society but under-consumed, because consumers do not fully recognise its private or external benefits.
For a positive externality of production, the free market fails through the of the good or service.
For a positive externality of production, the free market fails through the under-provision of the good or service.
How can a government correct the under-consumption of a merit good?
A government can subsidise the merit good to lower its price and/or increase the quantity demanded.
True or False?
On a diagram showing a positive externality of consumption, there are two demand curves.
True.
When the benefit is on the consumer side there are two demand curves; on the producer side there are two supply curves.
Define market failure.
Market failure occurs when free market activity results in a less than optimum allocation of resources from the point of view of society.
In the worked example, what welfare loss is caused by the positive externality of consumption?
The welfare loss is £600,000, found using (b × h) / 2 = (30,000 × £40) / 2.
Define common pool (access) resources.
Common pool (access) resources are resources that are non-excludable but rivalrous in consumption.
Define non-excludable.
Non-excludable means that anyone can access the resource without having to pay for it.
Why are common pool resources typically non-excludable?
Common pool resources are typically non-excludable because no one owns the resource (there is no private ownership).
Define rivalrous.
Rivalrous means that the resource can be used up, so as one individual or firm uses it there is less available for others.
True or False?
Common pool resources are infinite in supply.
False.
Common pool resources are finite in supply and can be used up, because they are rivalrous.
Define the tragedy of the commons.
The tragedy of the commons occurs when common pool resources are used in production in an unsustainable way.
The tragedy of the commons was explained by Garret Hardin in .
The tragedy of the commons was explained by Garret Hardin in 1968.
What type of externality does the tragedy of the commons create?
The tragedy of the commons creates negative externalities of production.
What external costs commonly result from overusing common pool resources?
Overusing common pool resources commonly causes external costs such as pollution, environmental damage and resource depletion.
Give two examples of common pool resources.
Examples of common pool resources include ocean fishing, communal grazing land, rivers and natural forests or rainforests.
In which country is the Darién Gap located?
The Darién Gap is located in Panama, on the border with Colombia.
True or False?
The 62-mile Darién Gap is the only point at which the Pan American highway is interrupted.
True.
The Darién Gap is the only place where the 19,000km Pan American highway from Ushuaia to Prudhoe Bay is interrupted, leaving a 62-mile gap.
Which valuable tree is being rapidly depleted by illegal logging in the Darién Gap?
The Rosewood Cocobolo tree is being rapidly depleted by illegal logging in the Darién Gap.
The Rosewood Cocobolo tree sells for $4,000 per m³ in Panama but $ per m³ in China.
The Rosewood Cocobolo tree sells for $4,000 per m³ in Panama but $12,000 per m³ in China.
Name one solution the indigenous community has attempted to protect the Darién Gap.
Solutions attempted include collective self-governance, forest mapping using drones, seeking legal ownership rights, and appealing for international agreements.
Define Pigouvian tax.
A Pigouvian tax is a tax placed on a product with harmful side effects, so as to increase its price and reduce the quantity demanded or the supply.
What principle underlies an indirect tax on a negative externality?
An indirect tax reflects the polluter pays principle, which makes the individual or firm causing the externality pay for it.
A carbon tax raises producers' costs of production and should reduce .
A carbon tax raises producers' costs of production and should reduce supply.
Define carbon tax.
A carbon tax is a tax on producers who emit greenhouse gases, setting a price on the carbon content so they pay for each ton of carbon dioxide (CO₂) emissions.
True or False?
An indirect tax completely eliminates the welfare loss caused by a demerit good.
False.
An indirect tax does not eradicate the welfare loss, but it moves the market closer to the optimum level of output.
On what does the effectiveness of an indirect tax on demerit goods depend?
The effectiveness of an indirect tax depends on the price elasticity of demand (PED) for the good.
Define producer subsidy.
A producer subsidy is a fixed amount of money the government gives firms per unit produced, to lower production costs and/or increase output.
True or False?
A producer subsidy shifts the supply curve to the left.
False.
A subsidy shifts the supply curve to the right, as it lowers the costs of production.
What type of market failure are subsidies used to address?
Subsidies address market failure where goods are under-provided or under-consumed, such as merit goods.
Define legislation as a method of government intervention.
Legislation refers to the laws governments create to limit the harm caused by the external costs of consumption or production.
What is the role of a regulatory agency?
A regulatory agency enforces the law and monitors that it is not being broken.
Raising the legal drinking age from 18 to 21 shifts the demand curve for alcohol to the .
Raising the legal drinking age from 18 to 21 shifts the demand curve for alcohol to the left.
True or False?
Indirect taxes can help create illegal markets.
True.
Some consumers seek to avoid paying the tax, which can help create illegal markets.
How does education help to correct market failure?
Education raises awareness of the external benefits or costs of a good, changing consumer behaviour over the long term.
Define tradable permit.
A tradable permit gives firms that emit greenhouse gases the option to buy a permit to pollute, and to sell any unneeded permits to other firms.
State one disadvantage of using education to address market failure.
A key disadvantage is that it takes a long time to change behaviour through education.
Define tradable pollution permits.
Tradable pollution permits are permits issued to polluting firms up to an optimum level of pollution, which firms can buy and sell, also known as a cap and trade scheme.
What emission does one pollution permit typically allow?
One pollution permit is typically valid for the emission of one ton of pollutant.
The price of a pollution permit represents an additional cost of production, which reduces the .
The price of a pollution permit represents an additional cost of production, which reduces the supply.
True or False?
Tradable pollution permits always reduce emissions, no matter how many permits are issued.
False.
If the initial number of permits is calculated too high, the permits will have no impact on emissions whatsoever.
Define international agreements.
International agreements aim to address the negative externalities of production and consumption that are global in nature.
Which body sets annual fishing limits in the North East Atlantic?
The North East Atlantic Fisheries Commission (NEAFC) sets annual limits on fishing in the North East Atlantic.
True or False?
Countries usually face legal consequences if they withdraw from an international agreement.
False.
There are usually no legal consequences to withdrawing from international agreements, as when President Trump withdrew USA support for the Paris Climate Change agreement.
Define collective self-governance.
Collective self-governance occurs when the stakeholders in a community work together to combat the negative externalities of production usually associated with common pool resources.
Which example shows collective self-governance promoting eco-tourism?
Collective self-governance has promoted eco (sustainable) tourism in the Borneo rainforests.
Define public goods.
Public goods are beneficial for society but are not provided by private firms due to the free rider problem.
Merit goods are beneficial to society, but consumers cannot always access them as they are of the market.
Merit goods are beneficial to society, but consumers cannot always access them as they are priced out of the market.
How are government-provided public goods usually paid for?
Government-provided public goods are usually provided free at the point of consumption but are paid for through general taxation.
True or False?
Providing goods free at the point of consumption can create excess demand and long waiting times.
True.
Products which are free may result in excess demand and long waiting times, such as procedures at public hospitals.
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